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The Advantages of Living Below Your Means

The health of our economy continues to improve. The sting of the housing bust and recent record-breaking unemployment is fading. Some Americans are taking on more debt (mostly education and car loans), perhaps feeling boosted by rising home values and increases in the values of their stock portfolios. But although the numbers have improved, many continue to live cautiously and are living below their means, wary of taking on more debt than they can handle. This is particularly true for younger people (under the age of 35), who have dropped their average debt load from $18,000 in 2001 to $15,000 in 2010 (the lowest level since 1995).

In days gone by, it was not uncommon to hear the advice that you should buy as much house (or car or vacation or what have you) as you could afford, even if doing so stretched your budget to its very limits. The thinking was that in due time – a year or two – you’d get a raise or promotion and earn more money, easing your financial strain automatically through life’s inevitable events. So if you could just survive on Ramen noodles for a short time – just months, really – you’d come out on top. This logic just doesn’t hold true anymore. And for anyone who has lost their home to foreclosure or been laid off (once, twice, even three times in as many years), the prospect of being unable to pay the bills is simply too unpalatable to chance.

While it’s easy to pounce on expensive daily habits like a $5 latte, it’s just as important to examine your finances from a higher level. For example, if you’re planning out your college experience, consider working more and borrowing less. Also, you might be able to complete your core or prerequisite classes at a junior college or community college for a much lower price. Here’s an illustration.

Bringing down the cost of college

In San Diego, a college freshman can satisfy the basic math requirement for an undergraduate degree at any one of a number of schools (assuming admission). Today’s prices for the same fully transferrable 100-level (freshman) Algebra course are as follows:

San Diego Community College District schools, for a resident student: $156

University of San Diego, for a full-time student (15 unit course load): $3,949

University of San Diego, for a part-time student (6 unit course load): $4,080

Any of these courses transfers fully to any other school, accredited or not, to fulfill the undergraduate requirement for the course. Clearly, the student who chooses to fulfill basic degree requirements at a low cost school (even if he or she plans to transfer to a more prestigious university later on) will have a distinct financial advantage upon graduation over those who choose to take out loans instead.

A great number of home buyers focus on the monthly payment amount when they shop for a mortgage. While not entirely unwise (you need to be able to afford your home today), it’s not an accurate view of the true cost of the home. Even on a good loan, we spend the first 15 or 20 years paying off the bulk of the interest. On a $200,000 mortgage at 3.6%, the payment is $909; when repayment starts, about $600 of that goes to interest. The amount that is applied to the principal balance goes up by around $1 per month for the first ten years. After ten years, more than half of your payment – $468 – still goes to interest charges. Over the life of the loan, you’ll pay over $127,000 in interest on top of the $200,000 you borrowed.

Does paying that much in interest feel uncomfortable to you? Or at least disappointing? It should. What if you paid for that home outright and saved all of those interest charges? That’s what Ann, a novelist from Ireland did. Extremely debt-averse, her strategy was to save until she could afford to buy a home. Then at age 36 she cashed out all of her savings, including stocks and mutual funds, order to avoid taking out a mortgage at all.

Think about Ann’s strategy. If you did what she did, you could replenish your savings by paying yourself every month, instead of a lender. No dollars spent on the privilege of using someone else’s money.

The big picture

If your entire mortgage payment went into your bank account every month, how long would it take you to build up a year’s living expenses? Not terribly long, especially when compared with the length of time it takes for a person to save the money if she or he is simultaneously obligated to pay down debt. Debt payments can easily consume the largest portion of your budget.

The advantages to finishing college with little to no debt, or owning a home with no payment, cannot be overstated. No creditor can put you into collections or foreclose on your home if you don’t owe any money. Your employment options are much greater because your cost of living is so much lower. Yes – give up that latte. And use coupons, eat at home and shop the clearance rack. Even if you have money in the bank. But realize why you’re doing it.